Government Action To Reduce Externalities

We all know the feeling: You’re on your way to an important business meeting (even a job interview) and then you end up stuck in a traffic jam. An hour later, you’re already late and you find out that the disruption was caused by some company digging up the roads. Then you think to yourself “Deja vu! I could have sworn traffic was held up by another road-digging crew yesterday, and the day before.” (NB: I don’t know the feeling, I don’t drive and I live on campus at university and secondly, WHY ARE YOU DRIVING IN LONDON? Tube, bus, maybe bike- but then I forget that you can’t be seen on the modes of transport of the masses even if it means sitting for such a length of time that you get a clot the size of your heart… IN YOUR LEG [Sorry for complaining, I understand perfectly]).

This is an example of a negative externality. Negative externalities occur when the market does not lead to the socially optimum price level and output level. Negative externalities arise when the private costs of a good are lower than the social costs (private costs+external costs) leading to a lower price level (as only private costs are recognised by the market) and thus to overproduction of a “bad” which leads to inefficiency and reduction in public welfare (does harm to society or reduces the overall good to society of having cars).

In this case the social costs would include the business deals or jobs that would be lost if everyone that was held up was late to work, their job interview or their meeting and can be estimated quite easily (I won’t) in monetary terms; this is the opportunity cost (to society) of sitting in a car for four hours instead of working. Other social costs include the pollution (smog, CO2 and other gases) from thousands of idly-running cars everyday; affecting the health of those in the area (passengers, drivers, pedestrians, road-diggers, those who live nearby) as well as contributing to climate change; and noise pollution. Even though these costs are quite difficult to estimate monetarily, it doesn’t mean they don’t matter, we shouldn’t try to, or that it is impossible to. For instance, costs of pollution can be estimated from the costs to treat or cure people who get respiratory problems mainly explained by constant exposure to gases emitted from vehicles.

Another way of reducing externalities (which I think is more efficient as it works through the market) would be for government to raise the private costs of the good to meet the social costs so that the new market equilibrium is at the point where social costs equals social benefits (socially optimum point). This can be done by the government taxing goods with externalities; the new car tax bands are an example- car taxation based on CO2 emitted by the car aiming to make people buy less emitting cars.

I first heard the term social engineering used to describe this type of government intervention some days ago in this Robert Frank NYT article (he writes about global warming, but the theme is transferable) which is unsympathetic to that view and tries to show that it is not a crime against individual liberty to tax harmful goods that some people gain satisfaction from consuming (h/t Mark Thoma):

…Although both proposals pass muster within the Coase framework, conservatives remain almost unanimously opposed to the cap-and-trade proposal approved last year in the House… Much of this opposition is rooted in a passionate distaste for “social engineering”…

But social engineering is just another term for collective action to change individual incentives. And unconditional rejection of such action is flatly inconsistent with the Coase framework that conservatives have justifiably celebrated. …

In the case of global warming, markets fail because we don’t take into account the costs that our carbon dioxide emissions impose on others. The least intrusive way to have us weigh those costs is by taxing emissions, or by requiring tradable emissions permits. Either step would move us closer to the conservative/libertarian gold standard — namely, the outcome we’d see if there were perfect information and no obstacles to free exchange. …

Finally, back to the issue I started with. There was an article in the Guardian about plans for the government to price and coordinate the road-digging/traffic disruption timetable in London (SHOCK, HORROR- GOVERNMENT) so as to reduce disruption and Londoner’s frustration. “Oh, I thought the government caused the disruption with too much regulation just like it causes everything?” No the private utilities did because they could. No regulation and no costs meant they could dig up the roads whenever they felt like it.